Continuing Municipal Disclosures: Are You in Compliance?

The U.S. Securities and Exchange Commission, or SEC, launched an initiative in 2014 to encourage issuers and underwriters of municipal securities to self-report certain violations of the federal securities laws rather than wait for their violations to be detected. The Municipalities Continuing Disclosure Cooperation, or MCDC, Initiative is intended to address widespread violations of the federal securities laws by municipal issuers and underwriters in connection with certain representations about continuing disclosures in bond offering documents. The SEC began issuing fines and penalties against underwriters in July 2015, and is now turning its attention to issuers.

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About the Author

Robert M. “Kinney” Poynter is the executive director of the National Association of State Auditors, Comptrollers, and Treasurers. NASACT is a professional organization whose mission is to assist state leaders to enhance and promote effective and efficient management of governmental resources. Kinney has B.S. and M.S. degrees in accounting from the University of Kentucky. He is a certified public accountant and a member of the American Institute of Certified Public Accountants. He previously served as a member of the AICPA Council.

On March 10, 2014, the U.S. Securities and Exchange Commission’s, or SEC, Enforcement Division announced the Municipalities Continuing Disclosure Cooperation, or MCDC, Initiative to provide issuers and underwriters the opportunity to self-report instances of material misstatements in bond offering documents regarding the issuer’s prior compliance with its continuing disclosure obligations.

According to the SEC, “continuing disclosures are a critical source of information for investors in municipal securities, and offering documents should accurately disclose issuers’ prior compliance with their disclosure obligations. This initiative is designed to promote improved compliance by encouraging responsible behavior by market participants who have failed to meet their obligations in the past.”1

Under the MCDC initiative, the SEC indicated that it would recommend standardized, favorable settlement terms to municipal issuers and underwriters who self-report that they made inaccurate statements in bond offerings about their compliance with continuing disclosure obligations specified in Rule 15c2-12 9, or the Rule, under the Securities Exchange Act of 1934, or Exchange Act. The SEC established two deadlines for self-reporting under the MCDC initiative:

  • September 10, 2014, for underwriters, and
  • December 1, 2014, for issuers.

As part of the initiative, the SEC did not define the term “material,” but it did indicate that a determination of materiality would be made on a case-by-case basis depending on the overall facts and circumstances of the situation. Accordingly, municipal market participants—underwriters and issuers—are watching very closely since enforcement actions will provide some insight on what the SEC determines to be material.

In response to the MCDC Initiative, the underwriter community conducted internal compliance investigations by reviewing the official statements for all bonds underwritten since 2009 and associated continuing disclosure filing data to confirm whether the official statements accurately described the issuer’s prior compliance with continuing disclosure undertakings. 

In most cases, underwriters compiled a list of bond issues that contained a misstatement regarding continuing disclosure compliance. These lists were compiled using continuing disclosure filings since 2009 made through the Electronic Municipal Market Access, or EMMA, platform of the Municipal Securities Rulemaking Board, or MSRB.

Although underwriters were encouraged to contact issuers with the results of their review to discuss any potential misstatements, they were not required to do so, and in some cases did not have time to contact all issuers because of the unreasonably short deadline for the MCDC Initiative—September 10, 2014. The difference between the reporting dates for underwriters and issuers caused confusion and even some discrepancies between noncompliance reported by the underwriter and noncompliance reported by the issuer.

The Requirements
The Rule generally prohibits an underwriter from purchasing or selling municipal securities unless an issuer has committed to provide annually financial information and operating data specified in a written Continuing Disclosure Agreement, or CDA. Additionally, the Rule requires underwriters to obtain and review a final official statement that discloses when the issuer has failed to file information required by the CDA during the previous five years.2 As such, the underwriter and the issuer have primary responsibility for continuing disclosure compliance.

While the Rule only applies to underwriters, and the SEC is prohibited from directly regulating issuers under the 1975 Tower Amendment to the Exchange Act, the SEC has demonstrated through recent enforcement actions that making false statements in official statements about compliance with continuing disclosure obligations will be construed as securities law violations under Section 17(a) of the Securities Act of 1933 and/or Section 10(b) of the Exchange Act.3

Because of the Rule, issuers of most municipal security offerings provide certain disclosures when issuing securities (primary market disclosures) as well as certain times thereafter (continuing disclosures). 
Continuing disclosure consists of important information about a municipal bond that arises after the initial issuance. This information generally reflects the financial health or operating condition of the state or local government as it changes over time or the occurrence of specific events that can have an impact on key features of the bonds. Continuing disclosure agreements normally require the following:4

Annual Financial Information

  • Financial information and operating data provided by state or local governments or other obligated persons.
  • Audited financial statements for state or local governments or other obligated persons, if available.

Event Notices

  • Principal and interest payment delinquencies.
  • Non-payment related defaults.
  • Unscheduled draws on debt service reserves reflecting financial difficulties.
  • Unscheduled draws on credit enhancements reflecting financial difficulties.
  • Substitution of credit or liquidity providers, or their failure to perform. 
  • Adverse tax opinions or events affecting the tax-exempt status of the security.
  • Modifications to rights of security holders.
  • Bond calls and tender offers.
  • Defeasances.
  • Release, substitution or sale of property securing repayment of the securities.
  • Rating changes.
  • Bankruptcy, insolvency or receivership.
  • Merger, acquisition or sale of all issuer assets.
  • Appointment of successor trustee.

MCDC Results
On February 2, 2016, the SEC announced its third, and final, round of fines and penalties against underwriters. In total, 72 underwriters were charged $18 million under the voluntary self-reporting program targeting material misstatements and omissions in municipal bond offering documents. According to the SEC, “As part of the settlements, 72 underwriting firms–comprising approximately 96% of the market share for municipal underwritings–have agreed to improve their due diligence procedures and we expect that investors will benefit from those improvements.”5

Now, the SEC is turning its attention to issuers. At this time, only one announcement has been made regarding issuers; however, it is anticipated that the SEC will be releasing the names of several more issuers soon. It is unclear what penalties might be assessed against the issuers, but it is certain that no government wants the negative publicity that will accompany an SEC finding of noncompliance. After all, government employees are entrusted with public funds, and with that high level of fiduciary responsibility comes an obligation to comply with laws and regulations, including continuing disclosures.

Ensuring Compliance: Do Auditors Have a Potential Role?
For several years, many municipal market groups—including the Government Finance Officers Association; National Association of Bond Lawyers; National Association of State Auditors, Comptrollers and Treasurers; National Association of State Treasurers; and the Securities Industry and Financial Markets Association—have strived to improve continuing municipal disclosures.

First, the organizations have worked to identify the major causes of noncompliance. Overall, it seems that a lack of knowledge and education is the primary culprit. For example, a small government issuer that goes to the market infrequently is not likely to have a system in place to remind key personnel of the disclosure requirement. Staff turnover is also likely—the finance manager or treasurer that issues the bonds may not be there five years down the road. Therefore, the continuing disclosure compliance requirements get overlooked. Similar issues can occur for underwriters, particularly small, infrequent issuers.

While great strides have been made, including a “tickler” in the EMMA system that reminds issuers of their continuing disclosure obligations, the MCDC Initiative has shown that compliance problems still exist.

In October 2015, the stakeholder groups reconvened in an effort to identify new ways to increase compliance in this area. While a number of ideas and suggestions were made, there was much discussion 
about the role of the independent auditor. In government audits, independent auditors test for compliance with applicable laws and regulations as part of their routine audit work.

Can the independent financial auditor be a key part of increasing compliance? Yes and no. The problem lies with the fact that the independent financial auditor is focused primarily on noncompliance with laws, regulations, contracts and grants that have a direct and material effect on the financial statements. Rarely, would noncompliance with continuing disclosure requirements rise to this level. Accordingly, most auditors would not specifically test compliance for continuing disclosures unless the government had a long history of problems in this area or similar extenuating circumstances.

Government Auditing Standards does provide that auditors should communicate “instances of fraud and noncompliance with provisions of law or regulations that have a material effect on the audit and any other instances that warrant the attention of those charged with governance.”6 (Emphasis added.) Accordingly, the professional audit standards do provide auditors some flexibility in this area. 

The National Association of State Auditors, Comptrollers and Treasurers conducted a survey in January 2016 to learn not only what testing state auditors are doing in this area, but also what communication and educational materials are issued by state comptrollers and treasurers to improve compliance. Survey results varied significantly. For example, Louisiana passed a statute in 2014 that required (1) all public entity issuers of securities to be in compliance and (2) auditors to test for compliance.7 On the opposite end of the spectrum were states that do not currently test compliance with continuing disclosures at all—due to the materiality issue discussed above—and do not provide educational materials to local government issuers.

There were a few states that have started inquiring of the government’s management about compliance and are considering adding this compliance item to the standard management representation letter. This would be a positive step, and especially important for small governments, since it would at least raise the issue with management each year.

The MCDC Initiative has demonstrated that improvements in continuing disclosure compliance are needed. It is equally clear that a one-size-fits-all regulatory regime will not work—there are simply too many different types of issuers in the municipal market ranging from very large states to small local governments or utilities.

Success requires a concerted effort by many different parties, primarily the underwriter and management of the issuing government. The issuing government should ask for assistance from bond counsel and the bond agent where appropriate. The independent auditor may also have a role to play as part of annual compliance testing as discussed above.

One thing is clear. The SEC continues to increase its focus on the municipal market. It is incumbent on issuers to comply with the terms of its continuing disclosure agreement. Now more than ever, it is critical to inquire about internal controls pertaining to compliance with continuing disclosures and make sure agencies are taking the necessary steps to comply.

Don’t be caught off-guard!

1 “SEC Launches Enforcement Cooperation Initiative for Municipal Issuers and Underwriters,” March 10, 2014, U.S. Securities and Exchange Commission, press release 2014-46, 
2 “Municipalities Continuing Disclosure Cooperation Initiative,” Modified November 13, 2014, U.S. Securities and Exchange Commission.
3 Government Finance Officers Association, “GFOA Alert: The SEC MCDC Initiative and Issuers,” July 7, 2014. 
4 Municipal Securities Rulemaking Board, “SEC Rule 15c2-12: Continuing Disclosure,” January 1, 2013.
5 U.S. Securities and Exchange Commission, “SEC Completes Muni-Underwriter Enforcement Sweep,” February 2, 2016, press release 2016–18.
6 U.S. Government Accountability Office, paragraph 4.23, Government Auditing Standards 2011 Revision, December 2011.
7 Act 463, Louisiana Legislature, July 2014.